SaaS Pricing Strategies: Understanding the Financial Impact

The single-most important financial lever SaaS startups control is their pricing.

Why? Your SaaS startup’s pricing strategy significantly affects its valuation by impacting revenue, profitability and overall growth potential. The best pricing strategies, along with your customers’ needs, work to maximize their willingness to pay and drive predictable and recurring revenue streams. Pricing decisions directly impact key SaaS metrics, such as MRR, CAC payback and the LTV:CAC ratio.

Despite this importance, studies indicate that most SaaS startups only spend a few hours on pricing strategy, which is way too little time when you consider the negative effects the wrong strategy can have on unit economics.

Why SaaS Pricing Is a Financial Strategy, Not Just a Marketing Decision

Pricing literally affects every financial metric investors scrutinize, underscoring its importance. It’s a big part of the reason why many SaaS startups turn to Fractional CFOs or other financial professionals to help set their strategy and choose the right pricing model. Pricing has a direct effect on key financial metrics, such as MRR, ARR, growth rates and cash flow projections, underscoring the importance of getting the strategy right from the start. Failure to do so can result in poor numbers and a lack of profit, even if you’re acquiring customers at reasonable customer acquisition costs.

Pricing strategy is one of the key factors that investors evaluate during the due diligence process to help gauge the potential of your SaaS startup as well as its financial maturity and fit with customer expectations.

The Core SaaS Pricing Models and Their Financial Trade-Offs

So what pricing model is best for your SaaS startup? There are three main pricing models that most implement, each with its own unique effects on unit economics and cash flow. Here’s a look:

• Flat-rate pricing: True to its name, flat-rate pricing charges the same price for all customers to access all the features of the product. It’s a simple model and easy to forecast, yet it doesn’t always capture the full value from customers who have different usage needs. This is especially true for high-value customers.
• Tiered pricing: Tiered pricing offers different packages with varying features and price points, such as “Basic,” “Advanced” and “Enterprise.” This allows SaaS startups to better cater to various customer segments and capture revenue by providing their service based on customer needs. While this pricing strategy is ideal for different customer segments, it requires careful tier construction.
• Usage-based pricing: This pricing model charges customers based on their consumption or usage. It’s most effective for services with high variable costs and tends to align best with value received. However, MRR is less predictable when it comes to financial forecasting.

Though not as common, other pricing models your SaaS startup may consider include freemium, feature-based pricing or a hybrid pricing model that combines more than one of these strategies.

Per-Seat vs. Per-Feature: What the Model Choice Means for Expansion Revenue

Per-seat models link expansion and growth to customer headcounts, while per-feature models tie it to the adoption of additional functionality as customer needs evolve. Both strategies have pros and cons. For instance, per-seat pricing helps your startup to scale naturally as your customers grow, but also creates an incentive for your customers to share logins, which can leave revenue on the table. Conversely, feature-based tiers help promote upselling, but tiers need to be properly segmented with different price points.

More usage-based models tend to be the preferred strategy for SaaS startups these days, with some 40 percent of startups considering a shift away from the per-seat method toward per user pricing. Most startups, however, are utilizing a blended approach that combines elements from both strategies to maximize their expansion potential and sustain revenue growth.

How Pricing Affects Your Most Critical SaaS Metrics

One reason pricing is so important to your SaaS startup is its impact on your key metrics. For instance:

• Higher pricing increases MRR and ARR. However, it may increase your CAC if sales cycles are longer and the conversion rate drops.
• Annual vs. monthly contracts can dramatically impact growth and cash flow. For instance, annual prepaid contracts may improve your cash runway with large, upfront payments. They also often result in lower CAC and lower churn. However, it can deter some customers and often comes with incentives to entice customers to pay for a year rather than monthly. Conversely, monthly contracts spread revenue out over time. While upfront cash and working capital are lower, conversion rates tend to be higher, and this can result in a more stable financial foundation for your startup. Most startups aim for a hybrid approach with a mix of annual and monthly subscriptions.
• Other pricing strategies, such as freemium, can negatively impact ARPU, but can have a more positive effect on CAC if your conversion rates are strong.

Value-Based Pricing: Aligning Price With Customer Outcomes

More startups are adopting a value-based pricing approach because it aligns price with expected customer outcomes. With value-based pricing, prices are set on perceived customer value and the measurable benefits that the product provides to each customer, essentially shifting the focus from the startup’s expenses to the customer’s willingness to pay for the value that they receive. This often results in higher profit margins for your startup and greater ARPU by anchoring to customer ROI rather than costs.

However, there are challenges involved with value-based pricing. For instance, it requires deep customer research to quantify value delivered and align pricing with customer perception. It’s best practice to follow the 10x rule, which suggests SaaS startups should charge a price that provides the customer with at least 10 times the value in return.

The Financial Implications of Pricing Changes

Pricing changes and adjustments are often necessary over time, but they can significantly impact existing and new customers, requiring careful financial modeling across different pricing models.

For instance, grandfathering long-time customers at original pricing can help protect your churn rate, but it also limits your customer base’s revenue-earning potential. Yet increasing prices risks elevating your churn rate, even if it instantly improves your MRR.

To best navigate the financial implications of a pricing change, take a strategic approach. Model different scenarios and act with transparency when communicating to your customers about why you’re raising prices, while being sure to highlight any additional value or features.

Discounting Strategy and Its Impact on Unit Economics

Discounts are another common pricing strategy many SaaS startups implement, but they can significantly impact unit economics.

For instance, heavy discounting can increase the likelihood of closing deals, which can lower LTV while CAC remains consistent. This isn’t ideal for unit economics. Annual prepay discounts help improve cash flow, but must be weighed against revenue reduction.

Expansion revenue is more valuable than discounted initial contracts, which is why SaaS startups should model full customer journey economics when weighing discounts.

Pricing for Different Customer Segments: Financial Considerations

Startups should also consider setting pricing for different customer segments, as trying to serve multiple segments with a single price point often fails. Different customer groups have varying needs, budgets and perceived value. Segmentation allows startups to offer tailored pricing models that maximize revenue, increase LTV and reduce churn.

Pricing strategies tailored to small and medium businesses should aim to optimize low-touch sales and product-led growth to manage CAC, while enterprise pricing should capture value through premium tiers, services and custom contracts.

How Your Fractional CFO Models Pricing Scenarios

Fractional CFOs are essential for helping your SaaS startup develop a pricing strategy through modeling and testing. A good Fractional CFO will model multiple scenarios that show the impact on MRR, cash flow, CAC payback and LTV:CAC ratios to help you decide which pricing strategy is best for you. They’ll also test pricing through controlled experiments with different customer cohorts to help your startup make the best decision.

Pricing strategy is important in growing your startup and securing investments during fundraising rounds. It can also help your startup create a financial story to tell when presenting to investors.

Turn Your Pricing Into a Competitive Financial Advantage

Are you ready to optimize your pricing and improve your key metrics? Graphite Financial is here to help. As a full-service financial partner that specializes in working with startups, we’ll help you identify and implement the right pricing strategy to optimize your metrics and growth. Contact us today for more information and to get started.

FAQ

What’s the best pricing model for early-stage SaaS companies?

Freemium or flat-rate pricing is the best pricing model for acquiring users and validating demand for early-stage SaaS startups. Freemium pricing offers a free basic version to attract users and then a paid plan for more features, while flat-free pricing offers a single, universal price for all features. As your SaaS startup grows and better understands its customer segments, tiered or value-based pricing is a better option. The three main pricing models that most SaaS startups implement are flat-rate pricing, tiered pricing and usage-based pricing.

How does pricing strategy affect SaaS company valuation?

A SaaS startup’s pricing strategy significantly impacts its valuation by impacting revenue, profitability and overall growth potential. The best pricing strategies, along with your customers’ needs, work to maximize customer willingness to pay and drive predictable and recurring revenue streams. A poor pricing strategy does the opposite for your startup.

Should we offer annual discounts to improve cash flow?

While offering annual discounts can be an effective way to improve cash flow, reduce customer churn and increase customer lifetime value, there are some notable downsides to this strategy to be wary of. For instance, annual discounts can result in less overall revenue and a lower perceived product value. They can also result in lower average revenue per user and less pricing flexibility, and they can attract more price-sensitive customers who aren’t as interested in your offering and are less likely to renew.

How often should SaaS companies review their pricing?

We suggest reviewing their pricing at least annually, though it may also be worthwhile to review pricing as often as quarterly so that you can make minor adjustments and stay more agile to changing circumstances.

What metrics indicate our pricing needs adjustment?

Three main categories of metrics indicate that a pricing adjustment is needed: profitability issues, customer behavior changes and shifts in the competitive landscape. The financial and profitability metrics you should be assessing are gross profit margins, CAC and price realization. Be on the lookout for high churn rates, high conversion rates and declining sales of core products. You should also be cognizant of external factors, such as shifts in competitor pricing, market share changes, negative feedback on your pricing and more.

How do we model the financial impact of a pricing change?

This is best done with the Price-Volume-Mix (PVM) analysis, which isolates how changes in price, sales volume and product mix affect your SaaS startup’s total revenue and profit. Key to this is the price elasticity of demand, which measures how sensitive sales volume is to price fluctuations.